March 2018 EUROPEAN GROWTH OUTLOOK
European economy flying high Cyclical peak in 2018 with a good two percent growth
The BDI expects the EU economy to grow by 2.3 percent this year. Last year, GDP increased by 2.4 percent. Europe has thus reached the peak of its economic cycle.
Capacity utilisation at 84 percent is reaching its limits and is just below the record level of 85 percent in 2007. Industrial production has expanded vigorously, and is three percent higher than one year ago. This is the same pace of growth seen in the interim high of 2011 but still below the pre-crisis level.
First bottlenecks on the labour market are curbing further economic momentum. The sustained period of high unemployment has led to an increase in structural unemployment and there are no indications of a wageprice spiral on EU level.
Training and active labour market policies must become a top priority of European economic policy. This will prolong the upturn and bring wageprice trends back to normal.
The federal government must now press ahead with reforms in Europe and Germany instead of pursuing a pro-cyclical spending policy. Tax breaks are not necessary in times of economic upturn – what Germany needs instead is investment in its long-term growth potential.
European economy flying high | Cyclical peak in 2018 with a good two percent growth 22/03/2018
Content European economy still flying high .................................................................................................. 3 Upturn across all member states .......................................................................................................... 4 Political uncertainty and too little reform endangering growth potential ................................................ 5 Growth of global economy still gathering pace .................................................................................... 5 Consumption remains driver of growth, investment picks up ................................................................ 6 Industrial activity high, capacity utilisation just below all-time high............................................. 6 Inflation to remain moderate in the medium term with no wage-price spiral ......................................... 8 ECB asset purchasing programme to run until at least September 2018 ............................................. 9 First corrections visible on financial markets....................................................................................... 10 Corporate lending picks up noticeably ................................................................................................ 11 Euro remains strong while dollar vacillates ......................................................................................... 12 Conclusions for Europe and Germany ........................................................................................... 14 Sources .............................................................................................................................................. 15 Imprint ................................................................................................................................................ 15
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European economy flying high | Cyclical peak in 2018 with a good two percent growth 22/03/2018
European economy still flying high The solid growth rates seen last year are set to continue in 2018. Last year, the EU28 grew by 2.4 percent and the euro area at a slightly lower rate of 2.3 percent. The European Commission predicts 2.3 percent growth for both the EU and the euro area in 2018 and two percent growth in 2019. This is consistent with OECD estimates of 2.3 percent for 2018 and 2.1 percent for 2019 (OECD 2018). The decisions of the new federal government have not yet been factored into these forecasts, so the upside risks outweigh the downside risks for 2018. In its 8 March 2018 forecast, the ECB (2018) predicted 2.4 percent growth for the euro area. The latest figures show the solid rate of growth continuing. In the fourth quarter of 2017, both the EU and the euro area grew by 0.6 percent over the previous quarter. Compared to the same period in 2016, growth was 2.7 percent and 2.6 percent respectively. Europe has now reached its cyclical peak. The first shortages on the labour market are already pushing growth down slightly.
Growth in real GDP in the EU in percent
4 3.0 3
2.1
2.3 1.8
1.7
2 1
0.4
2.4 2.0
0.3
0 -1
-0.4
-2 -3 -4 -4.3
-5 -6
I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV 2007
2008
2009
2010
change over previous year quarter
2011
2012
2013
2014
change over previous quarter
2015
2016
2017
change over previous year
Source: Macrobond
There are many factors behind this positive trend. One is the waning political uncertainty following the elections in the Netherlands, France and Germany. Only Italy remains a concern in the wake of its elections in March 2018. Now that the longwinded negotiations to form a government in Germany are over and the new grand coalition has been appointed, the uncertainty surrounding economic policy over the next legislative term has evaporated. During the last few months of 2017, ebbing political uncertainty led to rising investment, new jobs and higher demand in the EU (European Commission
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European economy flying high | Cyclical peak in 2018 with a good two percent growth 22/03/2018
2017). The favourable financing options are also having a positive effect. Open and export-oriented as it is, the EU economy is also benefiting from the economic uptrend outside of Europe. Fuelled by the ongoing economic recovery in many emerging economies and also in advanced economies, demand for European goods rose sharply last year. In a knock-on effect, trade between the EU and other countries also climbed (OECD 2017).
Upturn across all member states The upturn in the EU is occurring across industries and countries. The main driver of growth continues to be domestic and foreign consumption demand (IMF 2018). The individual countries of the EU are still, however, growing at very different rates. Romania and Ireland posted the highest growth. Poland is also among the top performers with over five percent growth, thanks to increased demand from the euro area. The country with the lowest growth last year was the United Kingdom, which is again set to bring up the rear in 2018. Progress in the exit negotiations has been minimal, with the future relations between the EU and the United Kingdom still anything but clear. Only a few countries are growing at below their growth potential and the output gap of European industry will close this year.
GDP growth 2017 and forecast for 2018 in percent 6
5
4
3
2
1
0
Growth rate 2017
Forecast 2018
Source: Macrobond
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European economy flying high | Cyclical peak in 2018 with a good two percent growth 22/03/2018
Political uncertainty and too little reform endangering growth potential Despite the buoyant economic sentiment, the important structural reforms required to consolidate the growth potential are not being implemented. The time window for reforms on the EU level is only open until the middle of this year due to the European Parliament elections in spring 2019. The first major point of reform is drawing up the multiannual financial framework (MFF) for the 2020 to 2027 period. A delay in decisions on the MFF would lead to an investment standstill at the beginning of this period. The second key point of reform is strengthening the European Economic and Monetary Union. A legislative proposal underway here is the transfer of the European Stability Mechanism into the EU treaties in the form of a European Monetary Fund. The architecture of the euro area urgently needs to be fortified. The current excellent economic conditions and low interest rates are concealing the risks posed by high debt levels and non-performing loans, for example. This problem is particularly pronounced in Italy. Brexit continues to be a factor causing considerable uncertainty. The negotiations on the exit modalities and lack of clarity on the shape of future economic relations are proving difficult. The first phase of negotiations was finally concluded in December, following agreement on fundamental issues such as Ireland, the rights of EU citizens living in the United Kingdom and the amount of exit payments to the EU. The second phase will now focus on negotiating the shape of future trade relations between the two partners. A further factor causing uncertainty is the outcome of the parliamentary elections in Italy. It will prove difficult to form a government. A possible new centre-right coalition headed by the Lega Nord, under the leadership of Matteo Salvini, could well stoke anti-European sentiment and weaken confidence in EU institutions and the common currency area; however, it is too early to say anything about the shape of the future government. Another volatile source of political conflict is the dispute between the EU and the Polish government over the launch of infringement proceedings against Poland in December. Growth of global economy still gathering pace According to the IMF, the global economy grew by 3.7 percent last year, thus considerably outpacing the EU economy. Growth is expected to accelerate to 3.9 percent this year and the next. In its most recent forecast, issued in March, the OECD (2018) is also predicting 3.9 percent growth. We even expect growth to reach four percent, as the IMF forecasts could not yet factor in the latest decisions of the US Congress and the new German coalition government (Deutsch et al. 2018). Both emerging countries and advanced economies are contributing to this momentum. The IMF is expecting the US to grow by 2.7 percent in 2018 and 2.5 percent in 2019. The Chinese economy, which grew by 6.8 percent in 2017, is expected to slow down slightly to 6.6 percent in 2018 and further to 6.4 percent in 2019. Asia is still the main driver of growth, accounting for more than half of global growth (IMF 2018). There has been further economic recovery in South America. The region is expected to grow 1.9 percent in 2018 and as much as 2.6 percent in 2019. The favourable economic conditions and the high level of demand have triggered a broad-based upturn in Brazil, which compensates for the recession in Venezuela. The region of the Middle East, the Maghreb, Afghanistan and Pakistan is continuing to catch up, with growth of 3.5 percent forecast for this year and next. Saudi-Arabia, in particular, is benefiting from the increase in oil prices last year. The upturn has also reached Sub-Saharan Africa, where growth is forecast to rise to 3.3 percent in 2018, following 2.7 percent growth in 2017 (IMF 2018).
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European economy flying high | Cyclical peak in 2018 with a good two percent growth 22/03/2018
Consumption remains driver of growth, investment picks up Private and public consumption, which contributed 1.7 percent to EU growth in 2016, only contributed around one percentage point in 2017 and will remain at around that level this year, too. A favourable development is the corresponding increase in investment and foreign trade. High levels of industrial capacity utilisation are having a positive impact on investment activity and will be creating strong momentum, particularly this year. Following a negative contribution to growth in 2016, foreign trade was slightly positive in 2017, a trend which will continue this year.
Contributions to growth in the EU 2.4
2,5 2.5 2.1
2.3
2.1
2,0 2.0 1.5 1,5
2.0
1.8
1.6 1.3
1.0 1,0 0,5 0.5 0.1
0,0 0.0 -0.5 -0,5
-0.5
-1,0 -1.0 -1,5 -1.5 -2,0 -2.0 2010
2011
2012
Private consumption Change in inventories
2013
2014
2015
Public consumption Net exports
2016
2017
2018
2019
Investment GDP growth
Source: Macrobond
Industrial activity high, capacity utilisation just below all-time high In January 2018, industrial production in the euro area was 2.7 percent higher than in the same month of 2016. After a particularly strong increase in the fourth quarter of 2017, however, production fell by one percentage point from December 2017 to January 2018 in a monthly comparison. Production is now at the same level as in 2011 but is still below pre-crisis levels. The year-on-year increase in investment of 1.4 percent in the third quarter was also the highest seen in three years. Sentiment in industry is excellent and the ifo business climate index in March 2018 even exceeded the level of 2007. The only time sentiment has ever been better was in 2000. Although the purchasing managers’ index slipped slightly down from its January level in February, it is still pointing towards further expansion.
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European economy flying high | Cyclical peak in 2018 with a good two percent growth 22/03/2018
Industrial activity* in the Euro area 116
50
114
40
112
30
110 20
108 106
10
104
0
102
-10
100 -20
98 96
-30
94
-40
Production*
Investment*
Purchasing Managers Index*
ifo Economic Climate (right axis)
*Index: Q1/2014 = 100 Source: Macrobond
The boom in industrial production is having a positive impact on capacity utilisation. In the major EU member states, capacity utilisation is now between 78 and 88 percent and has been increasing in all countries since 2012. The latest figures for the first quarter 2018 show capacity utilisation increasing everywhere except in the United Kingdom. The EU average is now close to the boom level of 2007.
Capacity utilisation in percent 90 85 80 75 70 65 60
EU
Italy
United Kingdom
Spain
France
Germany
Source: Macrobond
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European economy flying high | Cyclical peak in 2018 with a good two percent growth 22/03/2018
Pressure on willingness to invest is increasing further and the gap on the labour market is closing. Even though unemployment is still quite high in some member states, skilled workers are scarce in many sectors in all countries. The rate of unemployment in the EU at 7.3 percent in January 2018 is still half a percentage point below the pre-crisis level of 6.8 percent ten years ago. Unemployment is currently at 3.6 percent in Germany, but remains at 16.3 percent in Spain and 11.1 percent in Italy. A substantial proportion of this is structural unemployment that will go down significantly during the current economic boom. A key determinant for further economic development will be how fast and how successfully these workers can be trained and integrated into the labour market. Every delay here will curb the upturn.
Inflation to remain moderate in the medium term with no wage-price spiral Prices in the euro area increased by 1.5 percent in 2017, which is still less than the target rate of below, but close to, two percent. Inflation has flagged slightly according to the latest figures that show 1.1 percent for February 2018 and 1.3 percent for January. One reason for this is the appreciation of the euro, which is making imports cheaper. Core inflation (without energy and foods) has been stagnating for many years now at around one percent with no real upward momentum.
Inflation Core inflation in the Euro area in percent 5
4
3
2
1
0
-1
Inflation
Core inflation
Source: Macrobond
In its March forecast, the ECB (2018) is expecting an inflation rate of 1.4 percent for both 2018 and 2019 and slight increase to 1.6 percent and then 1.9 percent in the following years. The European Commission (2018) believes inflation will rise slightly more, expecting 1.5 percent this year and 1.6 percent in 2019 in its February 2018 growth outlook.
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European economy flying high | Cyclical peak in 2018 with a good two percent growth 22/03/2018
Inflation und Core inflation in percent 4
3
2
1
0
-1
Inflation
Core inflation
Source: Macrobond
The differences in inflation between the euro member countries has fallen over the last few months. While in autumn 2017 inflation ranged between 0.4 and 4.6 percent, the figures for February 2018 range from -0.4 percent in Cyprus to 3.2 percent in Estonia. This dispersion is being caused not just by different rates of growth in GDP but primarily by the dynamics of the individual labour markets. While the upward pressure on wages is already building up substantially in Eastern Europe and the Baltic countries, in particular, it is much lower in the other euro countries. There is nothing amounting to a wage-price spiral across Europe. Hidden reserves on the labour markets and low productivity increases are leading to moderate wage increases. In 2017, employee compensation increased by 1.6 percent (ECB 2018). The annual increases should rise to 2.7 percent by 2020.
ECB asset purchasing programme to run until at least September 2018 As expected, in October 2017 the ECB announced an extension of its asset purchasing programme until September 2018 for the time being. As of March 2018, the programme has been recalibrated from monthly purchases of 60 billion euros to 30 billion euros. This is a necessary step in view of the current upturn and the risk of bubbles forming on the financial and real markets. Given the subdued price acceleration and inflation below the two percent target, the ECB is in a complicated position. The upward trend of the euro is exacerbating the problem by keeping the prices of imports down. The ECB’s unconventional monetary measures are therefore likely to run on into 2019, followed by interest hikes. The OECD (2017) does not see the first hike happening until 2020. In the latest press conference on 8 March 2018, ECB President Mario Draghi prepared the financial markets for a slow phase-out of the ECB’s loose monetary policy. The usual rhetoric that the programme may be extended was not included this time.
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European economy flying high | Cyclical peak in 2018 with a good two percent growth 22/03/2018
Key interest rates in selected countries 7
6
5
4
3
2
1
0
European Central Bank
Federal Reserve Bank
Bank of England
Source: Macrobond
The Federal Reserve Bank (FED) already initiated a turnaround in interest rates in late 2016 and has implemented five hikes since then, each of 0.25 percentage points. The change at the helm of the FED with Jerome Powell replacing Janet Ellen in February 2018 could mark a shift in policy. Donald Trump’s economic policy agenda and mounting public debt would, however, rather speak in favour of a gradual increase in interest rates. To what extent Jerome Powell, appointed by Trump, will support this course is unclear. The Bank of England was also forced to hike up the interest rate in November 2017 due to an increase in prices of over three percent. Inflation here has since stagnated at around three percent, but the interest rate hike took some growth impetus out of the economy.
First corrections visible on financial markets Risks are already materialising on the financial markets in the euro area as seen by the recent correction of its stock markets. The EURO STOXX 50 Index crashed by around nine percent in early 2018. Similar price corrections took place on stock markets around the world.
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European economy flying high | Cyclical peak in 2018 with a good two percent growth 22/03/2018
Stock indexes 130 125 120 115 110 105 100 95
Germany
USA
Euro area
United Kingdom
Source: Macrobond
These price corrections illustrate the huge level of liquidity. The real economy has not yet been affected, although sentiment indicators such as the purchasing managers’ index have dipped slightly while remaining at a high level. Via this channel, volatility on the financial markets can quickly spill over onto the real economy. Other markets could also be affected by the revaluations. The Deutsche Bundesbank (2018), for example, has indicated that the overvaluation of property prices in big German cities has now reached around 35 percent. It will only be a matter of time before corrections are made. This makes micro and macro-prudential monitoring of the situation all the more important. The property prices are only marginally credit-driven, so the impact of any revaluations will be less drastic. Scenarios such as the US property crisis in 2007 are not to be expected on account of the higher level of equitybased financing.
Corporate lending picks up noticeably The second half of 2017 finally saw the long-expected increase in corporate lending to the real economy setting in. In January 2018, lending was 1.7 percent above the previous year’s level. This is the highest increase recorded since the start of the crisis, with the exception of the interim high in 2011. However, the recovery is still very moderate and not comparable to the dynamic growth rates of between five and twelve percent year on year recorded between 2000 and 2008. In spite of the slowly closing output gap and the acceleration in investment activity, there is no sign of overheating on the lending market in the euro area. More stringent financing regulations and the still moderate development of the property markets are certainly playing a role here.
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European economy flying high | Cyclical peak in 2018 with a good two percent growth 22/03/2018
Credit and Monetary growth in the Euro area, year-on-year in percent 20
15
10
5
0
-5
-10
Amount of credit
Money supply M3
Source: Macrobond
Excellent sentiment indicators and rising investment are the main drivers of this positive trend. The higher capital ratios of banks and the reduction in non-performing loans on their balance sheets is facilitating lending. The ECB pegs the proportion of non-performing debts in the third quarter 2017 at 4.2 percent. This is still well below the peak level of 6.5 percent in early 2015, but also well above the pre-crisis level of under three percent. Regional differences remain high, of course, ranging from around ten percent in Italy to 1.7 percent in Germany.
Euro remains strong while dollar vacillates Since the beginning of 2017, the euro has appreciated nominally against key trading partners by around eight percent. Euro area exports have remained largely unaffected by the appreciation, increasing by 1.1 percent in the second quarter of 2017 over the previous quarter, and by as much as 1.5 percent in the third quarter. Compared to the same period the previous year, the increase was 4.5 and 5.6 percent respectively. Imports, on the other hand, increased somewhat more moderately, going up 1.6 percent in the second quarter compared to the previous quarter, and 0.5 percent in the third quarter. Year on year, imports were up by 4.4 percent in both quarters. The rise in global trade is a major factor boosting the euro area’s foreign trade, which expanded by 4.6 percent in 2017 and is expected to keep growing at this rate in 2018 (IMF 2018).
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European economy flying high | Cyclical peak in 2018 with a good two percent growth 22/03/2018
Nominal exchange rates, respective foreign currency per euro* 120
115
110
105
100
95
90
Pound Sterling Swiss Franc US dollar Yen Renminbi Nominal effective exchange rate vis-Ă -vis twelve most important global currencies *increase means an appreciation of the euro against the respective currency Source: Macrobond, 01.01.2017 = 100
The US dollar has lost over 15 percent in value against the euro since January 2017. The euro area grew more than the US in 2016 and 2017, a trend which will probably turn around in 2018. Combined with further interest rate hikes, the dollar should appreciate this year. The further course of economic policy in the US is still unclear. The import tax on steel and aluminium announced recently could mark the beginning of a global trade war that would mix up trade flows and exchange rates considerably. The value of the British pound has more or less stabilised following its nosedive immediately after the referendum and has even appreciated slightly since the middle of 2017. The further development of the British currency will depend greatly on the outcome of the exit negotiations. The Chinese renminbi and the Japanese yen have depreciated between five and eight percent against the euro since the beginning of 2017. Factors driving up the euro are the surprisingly high rate of growth in the euro area and the ebbing political uncertainty in the Economic and Monetary Union. The transformation of the Chinese economy from an investment-driven to a consumption-driven society has proceeded without any signs of crisis so far, with growth remaining strong at over six percent. The depreciation of the renminbi, however, is a clear indicator of these risks.
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European economy flying high | Cyclical peak in 2018 with a good two percent growth 22/03/2018
Conclusions for Europe and Germany Europe is experiencing its highest growth in a long time. There are no signs of overheating yet, but first indications that momentum is ebbing are visible. Bottlenecks in some sectors on the labour market are slowing the upturn but have not caused the price of labour to spiral. Europe and the euro area in particular are in an unusual constellation of high growth, very low inflation and low wage increases. The extended period with very high levels of unemployment have led to a loss of practical skills and a rise in structural unemployment. This makes targeted training a top priority for economic policy, above all with a view to the wave of digitalisation and Industry 4.0. The current economic boom and the recovery on the labour market – particularly in Germany – must not distract from the urgency of tackling these challenges. Monetary policy can only unfold its impact if reserves on the labour market are activated and wage/price trends start to pick up.
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European economy flying high | Cyclical peak in 2018 with a good two percent growth 22/03/2018
Sources Deutsch, Klaus et al. (2018). Global Growth Outlook. BDI. Berlin. February. ECB (2018). Staff macroeconomic projections for the euro area. Frankfurt/M. March. European Commission (2018). European Economic Forecast Winter 2018. Brussels. February. ---(2017). European Economic Forecast Autumn 2017. Brussels. November. German Bundesbank (2018). Monatsbericht Februar. Frankfurt/M. IMF (2018): World Economic Outlook Update. Brighter Prospects, Optimistic Markets, Challenges Ahead. Washington DC. January. OECD (2018). OECD Economic Outlook. Paris. March. ---(2017). OECD Economic Outlook. Paris. November.
Imprint Bundesverband der Deutschen Industrie e.V. (BDI) Breite Straße 29 10178 Berlin T: +49 30 2028-0 www.bdi.eu Authors Dr. Wolfgang Eichert T: +3227921014 w.eichert@bdi.eu Sebastian Schuhmann BDI/BDA Business Representation
Editorial/Graphics Dr. Klaus Günter Deutsch T: +49 30 2028-1591 k.deutsch@bdi.eu Marta Gancarek T: +49 30 2028-1588 m.gancarek@bdi.eu This report is a translation based on „Wachstumsausblick Europa – März 2018“ as of 21 March 2018.
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